BackRaging retail inflation puts savings plans in disarray
People need to look beyond long-term financial plans to earn positive real returnsFDs cannot beat inflation given the nature of taxation; in today’s scenario it can be disastrous
PremiumThe unprecedented nature of the covid-19 crisis and economic uncertainty have prompted Indian households to save more during the pandemic, but the raging retail inflationary trends could derail their long-term financial plans.
Household financial savings rose from 7.9% of the gross domestic product (GDP) in Q1FY20 to 21.4% in the three months ended June, while deposits with banks picked up 11% at the end of June 2020, compared to the end of June 2019, according to the Reserve Bank of India’s quarterly report.
The preference for traditional savings instruments, such as bank fixed deposits (FDs), is well accounted for among most Indian households. However, with retail inflation at a multi-year high of 7.61% and FD rates bottoming out, it may not be wise to park your money in such instruments, considering the falling inflation-adjusted, or real rate of return.
“Investing in FDs for long-term goals, such as retirement, is always detrimental. FDs cannot beat inflation given the nature of taxation. In a high-inflation and low-interest scenario such as now, it can be disastrous. We are in a ‘negative real return’ situation. It means that while savings happen, the amount received at the end of the investment period will have lower purchasing power than the original investment amount. Hence, while it is good to postpone the pleasure and save for the future, in this scenario, the present is being sacrificed for the future, but the future becomes worse than present," said Renu Maheshwari, chief executive officer, Finscholarz Wealth Managers LLP, a Securities and Exchange Board of India-registered investment advisor.
The five-year FD scheme of State Bank of India is offering 5.4% interest, while the real rate of return will work out to be -1.8%, considering the existing rate of inflation. Furthermore, if we take into account the tax component on the interest earned from FDs, it will slide further. In fact, interest on FDs can be taxed at as much as 30% without surcharge and cess. Therefore, people will have to look beyond fixed deposits to earn positive real returns on investments to beat inflation.
Debt mutual funds could be one of the options. “Debt mutual funds chosen by matching the requirements of the investor with the specific types of fund and their duration is an alternative, wherein the investors can park their funds. There are different types of funds suited for differing needs, ranging from the time horizon of a few days to a few years. So, investors can choose accordingly," said Arnav Pandya, a financial consultant and founder of Moneyeduschool, an Ahmedabad-based financial literacy initiative. However, pertinent to note that debt mutual funds held for more than three years are taxed at 20% with the benefit of indexation.
Adding equity investments to the portfolio will also help as it has the potential to deliver inflation-beating returns, especially at a time when the stock markets are hitting life-time highs. “Investors can consider investing in equities and debt funds or even a blend of both the options to generate higher returns than inflation," said Harshad Chetanwala co-founder, Mywealthgrowth.com, a mutual fund distribution firm.
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